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Cicero Policy BrieferIssue 25, June 2008
Making the case for responsible investment in pension
funds
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| “There is an increasing body of evidence that ESG investment policy leads to more sustainable and predictable returns while aligning investment objectives with those of society” |
In light of what we have learned from the Stern Review on the Economics of Climate Change, a report commissioned by the UK Government, it makes sense that some MPs are calling for a responsible investment (RI) clause to be included in the Pensions Bill.
The Stern Review estimated that global warming could shrink the world economy by up to 20 per cent unless 1 per cent of global GDP is spent each year to resolve some of the issues. This warning underlines a significant threat to long-term corporate profitability unless appropriate mitigation policies are adopted.
On this basis, it is important to ask whether we have reached a point at which pension funds must adopt a scrupulous environmental, social and governance (ESG) policy, which is the main tenet of responsible investment, to ensure long-term performance is sustained and protected.
A proposal put before the House of Commons, and supported by both the Conservative and Liberal Democrat Parties, requests that the United Nations principles for responsible investment (UN PRI)1 be applied to the Government’s new national pension scheme and be embedded in the contractual arrangements between the Personal Accounts Delivery Authority (PADA) and asset managers. Meanwhile, speaking at the start of National Ethical Week in May, Labour’s Mike O’Brien MP, Minister of State for Pensions Reform, showed support for the PADA consultation on responsible investment.
These are welcome steps and there is an increasing body of evidence that ESG investment policy leads to more sustainable and predictable returns while aligning investment objectives with those of society2.
One document that makes the case for responsible investment is the 2004 UN report Who Cares Wins which argues that shareholder value can be enhanced by strong regard to ESG issues, particularly in a globalising world economy. The report stated:
“Companies that perform better with regard to these issues can increase shareholder value by, for example, properly managing risks, anticipating regulatory action or accessing new markets, while at the same time contributing to the sustainable development of the societies in which they operate. Moreover, these issues can have a strong impact on reputation and brands, an increasingly important part of company value.”3
Integration of ESG issues into portfolio management can add further value by improving stock picking and the corporate performance of holdings. Furthermore, due to the relatively low turnover of funds adopting an ESG strategy, broker fees and transaction costs tend to be lower than funds without an RI overlay.
But while there is evidence that an active corporate ESG policy can improve long-term stock returns, it should be expected that a responsible investment strategy will increasingly become a matter of risk management for pension funds. This is particularly true around the area of climate change mitigation, where the Stern Review made stark warnings4.
The severe flooding in the UK during summer of 2007, for example, has brought home the growing risk of weather related damage for property owners, house builders and insurers, many of which may be held in a regular pension fund. The UK’s total rainfall in May-July of last year exceeded that of any year since records began, and it is estimated that damages were at least £3 billion5.
In an environment where it makes economic sense for companies to anticipate and address the longer-term risks surrounding climate change, it is a logical step for managers of the Personal Accounts System (PAS) to pay due regard to these risks in their investment process.
At the heart of responsible investing is engagement with companies on a number of environmental, social and governance issues. At this level, investment and social interests intersect in terms of encouraging businesses to act responsibly in such areas as climate change planning.
Moreover, the simple act of favouring companies with positive strategies for addressing ESG issues itself becomes an incentive for companies to improve business practices if they hope to attract investment.
In terms of the scale of what is being proposed, a state-managed socially responsible pension fund is not without precedent. On the continent, the French Pension Reserve Fund (FRR), which is the country’s state pension scheme with assets of approximately €28 billion (as of 2006), has been a keen proponent of socially responsible investing.
The French scheme was established in 1999 with a long-term mandate aimed at covering a forecast pension shortfall in 2020. Believing that social and environment factors will increasingly affect investment performance, the fund has become one of the largest institutional SRI investors in the world and allocates assets to approximately 32 investment managers.
Commons debate on the Pensions Bill included reference to a responsible investment option in the scheme that members can select. We would welcome such a measure and believe this reflects the growth in interest in responsible investing by retail investors as well as pension fund members.
According to the Ethical Investment Research Service (Eiris), the number of policy holdings in UK ethically screened funds has risen from 137,000 in 1997 to some 720,000 in 2007. In this period, assets under management have risen from £1.5bn to £8.9bn6.
A similar pattern is emerging in UK pension funds where employees are demanding either a responsible investment option or, as has been the case for the Environment Agency pension fund, a social and environmental performance overlay. Additionally, Mike O’Brien MP has said that about a quarter of individuals eligible for a Personal Account would be interested in an SRI option.
We welcome the debate in the Commons and the news of plans for a wider consultation on responsible investment by PADA. We believe there is a very real opportunity here to create a positive framework in which the long-term investment performance for pensions is supported in a socially beneficial way.
At a time when environmental scientists are making ever more austere predictions about the threat of climate change, support for a responsible investment overlay on the proposed Personal Accounts System has never been more imperative.
Emma Howard Boyd is the Head of Socially Responsible Investment at Jupiter Asset Management and can be contacted here.
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By
Emma Howard Boyd, Head of Socially Responsible Investment, Jupiter
Asset Management